Performance, productivity, profitability

Kansas City Southern looks to its new international intermodal corridor for sustained growth.Kansas City Southern is "the best growth story in rail." That proclamation, made recently by Dahlman Rose Director-Equity Research and Railway Age Contributing Editor Jason Seidl, characterizes a railroad that for the past 15 years has grown and prospered under the leadership of Mike Haverty, one of this industry's great entrepreneurs.

Any measurement that can be applied to KCS—performance, productivity, profitability—shows a railroad where entrepreneurial spirit, and a "can do" philosophy, define the corporate culture.

KCS's second-quarter financials (details, p. 10) are indicative of the railroad's strength and resiliency. "A year ago, KCS was in the depths of the worst freight recession since the Great Depression," Haverty said when the company released its figures. "Over the past year, we have seen a steady improvement in traffic levels. During the quarter, we continued to bring on new business and improve operating margins. Our reported 72.4% operating ratio is a 15 percentage point improvement from a year ago, and represents a record operating ratio."

Now 66, lifelong railroader Haverty has assumed the role of Executive Chairman, passing along the responsibilities of day-to-day managenent to new President and CEO Dave Starling, who has been chief operating officer since July 1, 2008. Haverty, who as chief operating officer of the Santa Fe in the late 1980s gave birth to rail/truck intermodal partnerships with the landmark J.B. Hunt deal, now concentrates solely on long-term strategy and planning.

Starling's assumption of KCS's throttle "was planned two years ago when Dave came to Kansas City from the Panama Canal Railway [where he was president]," Haverty told Railway Age last month in the company's gleaming new headquarters building. "The transition has been absolutely seamless. He's developed our capital plan, and our transportation service plan was done under his direction."

Haverty and Starling have a personal and professional relationship going back to the 1980s, when Starling was a superintendent with the Burlington Northern and Haverty was a Santa Fe executive. Starling's background includes executive positions with APL and Mi-Jack Products. His background in railroading, ocean shipping, and intermodal solidly position him for carrying out Haverty's long-time vision of developing Mexico's Port of Lázaro Cárdenas into a major intermodal terminal, a time- and cost-effective alternative to Los Angeles and Long Beach.

"Lázaro Cárdenas has nine ocean carriers calling today," says Starling. "Hutchinson Port Holdings is the operator; they're working on the second phase of an expansion that should take the port to about 1.3 million TEUs a year. There's another phase that would take it to about 2.2 million TEUs of capacity. The Mexican government is talking about opening another concession, which would have a footprint equal to the size of the first concession. That means there could be another 2 million TEUs capacity coming on line in the next few years."

Lázaro Cárdenas serves a Mexico City region of about 55 million people. Some carriers like to use the port because it's strategically placed and is a deep-water facility. Logistically, it's ideal for ships with containers bound for both Mexico and the U.S. "It's got capacity in a horseshoe shape that can actually equal Long Beach or L.A.," Starling says. "There's enough buildout area to get into the 10, 12, or 14 million TEU area, so there are no restrictions. Right now, it's serving the Mexico City market and the industrial corridor north through San Luis Potosi and Monterrey to Nuevo Laredo. Our railroad (KCS de Mexico) serves that industrial corridor, right through the heartland. We do have some business coming up from Lázaro Cárdenas into the U.S. [to Houston], but right now, it's mainly the Mexico City port. We enjoy about a 60% market share coming out of the port going into the three major locations in Mexico."

Lázaro Cárdenas is more than an intermodal facility. It's a full service port that can handle grain, automobiles, and other traffic. "One of our biggest accounts there is Pemex," Starling notes. "We take heavy fuel out of their Toluca refinery and transport it down to Lázaro Cárdenas. We have a transload facility there, and the fuel moves by truck into Lázaro for refining and export. We have automobiles manufactured in Mexico that are going outbound, and we have them coming in both directions through Lázaro."

KCSM serves several major automotive manufacturing facilities in Mexico—General Motors, Ford, Chrysler, Nissan, and Volkswagen. (The Volkswagen plant in Puebla, near Mexico City, has an innovative parts in/finished autos out logistics program involving KCSM, Ferromex, BNSF Railway, and Greenbrier AutoMax motor vehicle carriers that will be featured in an upcoming issue of Railway Age.)

The business development opportunities keep coming. "We're now starting to get some of the finished vehicles into the U.S. for delivery to connecting lines," says Starling. "Auto parts are moving in containers out of the Detroit and Chicago areas down to the Laredo gateway and into a lot of the plants we serve. This has allowed us to win more contracts on finished vehicles. Plus, it gives us part of the backbone for our intermodal service. We've started a cross-border intermodal service that comes out of Lázaro Cárdenas and goes through Mexico City. It picks up finished autos from the plants, starts north and then makes stops at San Luis Potosi and then Monterrey. Those are our three major gathering points for intermodal in Mexico. We cross the border at Laredo for the Houston market. The same service connects with our intermodal train that runs from Dallas to the Southeast over the Meridian Speedway to Atlanta, Charlotte, and Jackson, Miss. At Freeport, Tex., it goes north on another train that connects to the Meridian train that we operate from Kansas City with a gateway into Marion, Ohio, with Schneider National and also with CSX for the Northeast. So we now have intermodal service out of Mexico over two different gateways."

One of the capital improvements that makes this all possible is KCS's recently completed Victoria-Rosenberg, Tex., line, which eliminates 157 miles of trackage-rights running over the Union Pacific. Re-opening this former Southern Pacific line, which KCS purchased from UP, is one of the railroad's most significant capital improvements. The rebuilding project was completed in the midst of the Great Recession last year. As Haverty tells it:

"We were halfway to completing the Victoria-Rosenberg line when the recession hit. We made the decision to go ahead and complete the line. We had a very ambitious five-year capital plan, and we were up on that plan until the bottom fell out in 2008. But we were spending a lot of money on capital—new locomotives, capacity expansion, and so on. We were spending knowing that we had a negative free cash flow but we knew that if we spent that kind of money in the short term with the projections that we had, that it was worth it."

When its capex plan was in full swing, KCS was pouring up to 31% of revenue into the railroad, "which is a little higher than the industry standard," Haverty says. Last year's program was $115.4 million. "Now that the Victoria-Rosenberg line is complete, we are within the industry norm, which is in the 16% to 17% of revenue range," he says. This year's program is $52.3 million, of which $42.2 million, $2.2 million less that 2009, is for roadway. Equipment spending is up, to $3.3 million from $2.3 million. Information technology spending is also up, to $3.4 million from $2.7 million. The big drop comes in capacity expansion: The 2010 expansion program this year will be minimal—$200,000—compared to 2009's $44.2 million.

"Most of our capital now is being spent on core maintenance of the system, so we can always run a safe and efficient railroad," Starling says. "We really don't have a lot of capacity expansion planned, but because of our cross-border intermodal service, we're spending money on our intermodal facilities, like CIC Houston-Metro, our new facility outside of Houston. We're also doubling our capacity in Monterrey this year. We purchased a facility outside of Mexico City called Puerta Mexico. It was a turnkey facility that had been built a few years ago, and it's on our main line. So we purchased it, and we now have it fully integrated into our KCS system. It's on the western outskirts of Mexico City, toward Toluca. So, we're back into maintenance capital, but we're also keeping an eye on intermodal because we think intermodal and automotive will be the fastest growing market segments in 2010 and probably into 2011."

"When we developed our business plan for Mexico back in 1996, we always focused on the truck traffic," Haverty recalls. "But once we got the concession, our partner (TMM) didn't care about moving any traffic over our system even though they had a contract that said they would do that, so consequently we never developed the international intermodal corridor that we're focused on now. It's only really been since 2005 when we took over Mexico ourselves and then the next year when we got the full 100% [of TFM] that we have started trying to focus on the intermodal side. Dave Starling and [Executive Vice President Sales and Marketing] Pat Ottensmeyer really understand what it takes to put together an international intermodal corridor. This is our growth opportunity, and it's starting to take off—in fact, all of our Mexico business is starting to take off. We had to have control in Mexico to really be able to move traffic over the long haul. Today, about 25% of our total revenues are from cross-border traffic. That was not the case before we took control. We signed a lot of new contracts that are now coming up for renewal, and we're aggressively going after business. That's our strategy."

Now that Mike Haverty has turned the day-to-day reins over to Dave Starling to concentrate on KCS's overall direction, he has a chance to take a breather and reflect upon everything that has transpired under his leadership. "I've been here 15 years," he says. "I look back on what it was like in May of 1995, with all the big mergers taking place and people writing our obituary. It's been a challenge, but I have to say that it is gratifying at this point to be able to see how far we've actually come, and to see guys like Dave and the team we've got. They're managing the way that I've always kind of envisioned it. We're getting a lot of things straightened out in Mexico. We've got all the trackage rights issues straightened out. Lázaro Cárdenas has come a long way, and we're going to complete Palm Island as a support facility. And we have some really good people right now. I can look at our railroad over a 15-year period and see that we've made a lot of progress."

Adds Dave Starling, "We may not be the largest Class I, but there's a lot of pride in the company. We're fighters."

Indeed. KCS last month battled flooding in Mexico caused by Hurricane Alex that temporarily shut down the Laredo Gateway, creating service embargoes. Crews worked round the clock to rebuild battered bridges and repair track washouts. The service disruptions may impact third-quarter earnings, but this railroad is used to bouncing back from adversity.